Why Bitcoin is on the money

Digital currencies are a threat to current financial systems, say Alec Ross
and Jonathan Luff.

Hackers also targeted the Bitcoin platform Instawallet earlier this year, stealing more than 35,000 units.

By Alec Ross and Jonathan Luff

9:14PM BST 24 Jun 2013

Around the world, governments everywhere are trying to come to terms with technology. Some are finding the pace of change too fast and the flow of information too free for their autocratic hierarchies, and they risk being swept away.

In the US and the UK, attempts to generate efficiencies and drive wider social benefits from digital technology have delivered uneven results. There is tension between the proponents of technology-driven change and those who seek to uphold long-established legal, economic and social structures, as witnessed in the arguments over intellectual property between the tech giants and the creative industries, and the heated debate over the surveillance of electronic communications. It is clear that policymakers and those who advise them do not have a satisfactory conceptual framework for dealing with the disruptive impact of technology on society.

At the G8 meeting in Northern Ireland last week, the focus was on three Ts: Trade, Tax and Transparency. The aim was to boost the global economy while responding to popular concern about the ways in which large corporations and wealthy individuals have used technology-driven globalisation to minimise taxes. This is an important agenda for taxpayers, and progress is being made.

Largely unnoticed, an interesting advert appeared in a handbook accompanying the G8, placed by a company that was until recently known only to a small number of technology entrepreneurs and early adopters. The advertiser was Mt Gox, a marketplace for trading BitCoin, a digital currency. The message was that with more than 7,500 legitimate businesses using a single BitCoin payment processor (BitPay), digital currencies have arrived, and existing currencies and regulators had better take note. And so they should, because the technology that powers digital currencies like BitCoin presents a challenge to those, such as the G8 governments, currently exercising sovereignty over our societies.

BitCoin itself is a peer-to-peer digital currency which, unlike the currencies found in virtual worlds such as Second Life’s "Linden Dollars", can be used to purchase real-world as well as online goods and services. The people who created BitCoin remain something of a mystery, but its innovative peer-to-peer structure and the sophistication of its code has helped establish it as the leader in this field.

BitCoins are "mined" by peers in the BitCoin network, who apply computing power to solve complex mathematical problems. This work also serves to authenticate and record every transaction made in or with BitCoin, avoiding the need for any central regulator or clearing house. Once mined, the BitCoins can be stored in a digital wallet on a laptop or smartphone, and then used to buy goods or services from anyone willing to accept digital currency, or traded for other currencies via exchanges such as Mt Gox.

Alternative currencies are, of course, nothing new. Many Londoners carry an Oyster Card, which they load with traditional currency and then exchange for travel. A plethora of digital currencies now exist, some used by online gamers within communities like World of Warcraft; others on mainstream e-commerce platforms such as Amazon. The total value of the virtual currency in circulation is increasing rapidly, with BitCoin alone valued in excess of $1bn.

BitCoin has risen to prominence this year in part thanks to the spike, crash and subsequent recovery in its value. This rollercoaster, plus the suggestion that its primary function is to facilitate criminal activity, has piqued the interest of both the mainstream media, regulators and law enforcement authorities.

Technology is reinventing finance. For the individual, there is a widening array of options for receiving, holding, transferring and spending the money that we earn; likewise, for governments, there are opportunities to reduce costs, simplify processes, and engage with citizens. In the developing world, value transfer via SMS is already replacing cash. With virtual currencies like BitCoin now operable without the need for a bank account, why would you open one? We need to ask whether the 5bn people coming online in the next five years will want to use our conventional financial tools and systems. We have hardly made a persuasive case for them in recent years.

This phenomenon is part of a wider trend towards networked and globalised power structures that tend to undermine the nation state-based systems to which we have grown accustomed. Last week, the world’s most powerful nations grappled with the complexity of a global tax system. But almost unnoticed, the rise of digital currencies like BitCoin threatens to render obsolete even the modest progress made by the G8. BitCoin's distributed network structure makes it hard for any one country or group of countries to regulate its activities. This is one of the currency’s main appeals for some early users, and it is only a matter of time before larger players begin to exploit the opportunities presented by immediate and secure value transfer, delivered anonymously and at next-to-zero cost.

Mainstream adoption ought, in our view, to come about via an accommodation between the new currencies and the old regulators, just as the offshore financial centres are making concessions on tax transparency and company ownership. If states remain disengaged from these digital currencies, who will protect their citizens in cases of fraud or hacking, the unfortunate but inevitable corollary of any virtual product?

To tackle such serious threats there is no realistic alternative to the international system of sovereign states that continues to police international peace and security, but which may not be well-adapted to the globalised digital age.

Unless the issues that BitCoin raises are addressed in a thoughtful and proactive manner by existing authorities, the disintermediating power of technology is likely to have a disruptive impact on currency systems and those that regulate and rely on them. And the effect could be as significant for governments as the rise of social media has been for individuals.

Alec Ross is a former senior adviser on innovation to Secretary of State Hillary Clinton; Jonathan Luff is a former international affairs adviser to Prime Minister David Cameron